Is It Time To Buy Merck?

My favorite app on my Apple (NASDAQ:AAPL) iPhone has to be the simple "Stocks" program that comes pre-loaded on this clever smartphone. Every time I hear a recommended stock, I add it to my list--creating an eclectic collection of stocks from many different industries. For those of you who have this app I would encourage you all to do what I do and utilize this program. In fact, my favorite way to use this app is to hold the phone sideways and view the 2-year charts on all of these stocks. There is much to learn by examining charts of potential investments.

One of the companies that is on my phone, yet is not a holding of mine, is Merck & Co. Inc. (NYSE:MRK), the multinational pharmaceutical firm. Looking at the 2-year chart of Merck it appears that this stock is 'breaking out' on the upside. I thought it would be wise to take a closer look at this company and share with you my observations.

Since we talked about charts, let's take a look at the StockCharts 'point and figure' chart on Merck:

Click to enlarge

Certainly, this stock has been under pressure after peaking in January 2008, at $50, dipping to as low as $18 in March, 2009. Since then the stock has moved higher and now appears to be breaking out after moving higher than the recent high of $37 made in January, 2010.

Merck is scheduled to report its earnings this Friday. The company has already pre-announced that it will report below expectations. Is this stock a buy?

On February 2, 2012, Merck announced 4th-quarter 2011 results. Earnings came in at $1.51 billion or $.49/share vs. a loss of $(531) million or $(.17)/share last year on charges. Excluding 'items,' Merck came in at $.97/share beating expectations of $.95/share per Thomson Reuters. Revenue, however, missed expectations, coming in ahead by 2% over the prior year at $12.29 billion but below street expectations of $12.53 billion. A mixed report at best.

And longer term? According to Morningstar, Merck has grown its revenue from $24.2 billion in 2007, to $48.0 billion in 2011, diluted earnings/share increasing from $1.49/share in 2007, to $2.02/share in 2011, with outstanding shares actually growing from 2.2 billion in 2007, to 3.1 billion in 2011.

In terms of basic balance-sheet numbers, Merck is reported by Morningstar to have $33.2 billion in current assets and only $16.2 billion in current liabilities yielding a healthy current ratio of over 2. Free cash flow has grown nicely from $6 billion in 2007, to $10.6 billion in 2011. This company is certainly financially healthy at least from these basic figures and generally has plenty of cash.

Reviewing the Yahoo "Key Statistics" on Merck, the company is a large-cap stock with a market capitalization of $116.5 billion. The trailing P/E is a moderate 18.95 with a forward P/E (fye Dec 31, 2013) estimated at 10.34. However, even with this growth the company comes in a bit rich with a PEG of 2.54.

There are 3.04 billion shares outstanding with all 3.04 billion shares that float. As of March 30, 2012, there were 16.08 million shares out short with a short interest ratio of 1.00.

The company pays a very nice dividend of $1.68/share yielding 4.3%. The company uses a good chunk of its earnings to pay this dividend with a payout ratio of 77%. The stock last split its stock February 17, 1999, with a 2:1 stock split.

Merck reports what appears to be a solid pipeline of drugs in development. However, the bottom line remains the actual business results and I look forward to seeing what this Friday report will bring. If we can see results that beat expectations in both earnings and revenue then I will be further encouraged. Similarly if guidance suggests optimism on the part of management this would be a sign that Merck is back in business as a formidable growth stock investment.

However, unless you are a dividend investor, in which case Merck with its 4.3% yield is quite attractive, I am not convinced that the chart is enough to warrant a purchase. The company has doubled its outstanding shares the last five years making earnings growth that much more difficult. Last quarter was a mixed result with a beat and a miss in the earnings department. While the P/E isn't bad, especially the forward P/E by estimates, the PEG over 2.0 makes valuation problematic. I do like the solid balance sheet and the outstanding free cash flow results.